Conning Asset Management is buying mortgage-backed bonds, both pass-throughs and collateralized mortgage obligations, on the view that credit deterioration and a historically steep yield curve will continue to help the sector outperform. Karen Kelleher, portfolio manager who oversees $1 billion in the firms $30 billion fixed-income portfolio, says the firm has moved away from investment-grade corporates (the firm's traditional asset of choice) and purchased Fannie Mae and Freddie Mac pass-throughs in the 6-6.5% sector of the coupon stack. She has also been buying 10-year original life PAC CMOs, backed by conventional 6-6.5% collateral, believing that the negatively convex structure will protect from extension risk. The moves have been financed with cash from MBS that prepays, as well as from the sales of shorter average life CMOs. Kelleher says she might purchase an additional $40 million or so of MBS, should the curve stay in this range, bringing the firm roughly in line with the MBS weighting of the Lehman Brothers aggregate index.
Kelleher will look to reverse this trade and get long corporate credit (mostly investment-grade), when the curve begins to flatten out. She says triggers here would include a narrowing of the spread between 10- and 30-year Treasuries to 50 basis points from the present 80, and a sharp equity correction.
The firm has an asset allocation of 50% corporates, 30% MBS and 20% treasuries and agencies. With a duration of 5.3 years, it is long its benchmark, the Lehman Brothers aggregate index, which is currently at 4.5 years.
